The Euro Zone of Denial Hits the Wall

The eurozone’s efforts to fence in Greece’s debt problems have consistently lagged events. The recent summit — the latest in a long series — addresses many key issues, but skeptics say few critical details were resolved and potential pitfalls still lie immediately ahead. The agreement also falls short of addressing longer-term root issues — underlying trade imbalances and an ultimate “backstop” role for the European Central Bank, some critics argue.And now Italy’s financial crisis is beginning to worsen, despite Prime Minister Silvio Berlusconi’s pledge to resign. Another big worry: Creditors could lose all confidence in Europe’s ability to fix these problems, creating a self-fulfilling prophecy that leads to a collapse in Europe’s banking system and other parts of the global economy, including U.S. financial markets. So, does the summit offer a sustainable path to stability or another “muddle-through” solution, as many expect?

To help understand the big picture, Knowledge@Wharton spoke with Wharton finance professor Franklin Allen and Wharton management professor Mauro Guillen about causes and cures, barriers to long-term solutions and the cultural differences that always lie under the surface. While the interviews were conducted the day before the summit, key provisions were already broadly understood in advance and are covered in the discussion. After the outline of the agreement was released, Guillen noted the outcomes “are not a surprise. The details need to be worked out, but at least we know for sure the general form of the solution. For me, an intriguing aspect is the role that outsiders, for example, China, might play. Still, this is a problem only the Europeans can solve.” Meantime, confidence in the grand deal is looking shaky as the cost for Italy to issue bonds to cover its debts has soared to euro-era highs, causing increased concern that the troubled eurozone will drag down the entire global economy.

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